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I poured my morning coffee, unfolded my newspaper, and nearly choked on the headline: RBS Admits Decades of IT Neglect. All I could think was, “You blithering idiots!”
I’m not going to discuss RBS share price (LSE:RBS) today, although I will say that it is, inexplicably, up 0.30 pence to 331.40, about one-tenth of one percent. Instead, I am prompted by the RBS story to attempt to enlighten some investors regarding the unseen management madness that has infected altogether too many public companies at the risk of shareholders investments.
Management’s general responsibility is to provide goods and services in a process-controlled environment that results in the generation of profit to the benefit of the shareholders and the continuance of the business.
I agree that my previous statement may be oversimplified, but for the sake of writing an article instead of a book, I’m going to keep it at that. The RBS IT breakdown and its admission that it has neglected its IT needs for decades would be enough for me to sell my shares, if I owned them. What happened is bad enough, but what caused the crash is my concern – and it ought to be yours. What happened is bad management in pursuit of a reasonable goal.
Cost reductions, generally speaking, are neither good nor bad. I am quite happy as an investor to see that a company is reducing costs by eliminating unprofitable, non-core business. I am happy because this is a strategic cost reduction and it is usually of the kind that is spread out over several years. I am particularly happy when the explanation for those reductions are explained in a way that makes sense for the overall good of everyone involved. On the other hand, I get a wee bit anxious when costs are being reduced in an effort to save a company that is obviously dying organically. Those costs reductions are attempts to keep the company from bleeding out.
What infuriates me is when it becomes obvious that a company like, for instance, RBS has a major crash in a part of its operations because it decided somewhere along the way to cut costs by reducing capital expenditures. This is dangerous territory, and whilst executive and senior management may think that they are reducing costs, generally they are sowing the seeds for the destruction of their company. Division and departmental managers despair when they are expected to operate effectively without investment in new technology and equipment. Let me share a real-life example other than RBS. A very well known US company collapsed because its idea of cutting costs was not investing adequately in capex. As machinery aged and wore out, it became nearly impossible to maintain engineering specifications for the product. Quality engineers were forced to accept non-conforming product, else there would have been no product to sell. Repairs to the equipment were costly, short-term solutions. Meanwhile competitors, who were willing to invest in new technologies and modern equipment, began to demonstrate that they had a consistently superior product. I don’t need to tell you how the story ends. Whilst this is the true story of one specific company, it is, at the same time, the true story of many others. And now, I will get to my point.
As investors we need to dig a little deeper to try to ascertain how a company is approaching the issue of cutting costs. I submit to you that a red flag needs to be raised when the reductions are significant in capital expenditures. I further submit that excellent companies distinguish themselves from average companies when they commit to continuously focus on cost avoidance as an operating principle as opposed to cost reductions. I realize that I have only a few hundred words to make my point and that I am already well beyond my normal limit. Lord willing, I will take up this matter again tomorrow or in the near future. It is important that investors know the difference and, to whatever extent possible, discover the underlying approach of management to ascertain whether investing in a company is a reasonably good idea based, in part, on the company’s approach to cost reductions and capital expenditures.
